Tax the rich, not small business

Small business growth powers the economy. If Obama extends the tax cuts on small business owners, will that hurt more than it helps?

ByDavid R. FrancisOctober 14, 2010

President Obama and Sen. Patty Murray, D-Wash., take part in a roundtable discussion with small business owners at Grand Central Bakery in Seattle, in this Aug. 17 file photo. Small businesses, from bakeries to tech startups, drive the jobs engine of the economy. Taxing small business owners helps reduce the deficit, but may also slow job creation.

Carolyn Kaster / AP

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Opinion polls find that the public has far more confidence and trust in small business than in Congress – around 59 percent versus about 7 percent. It's no wonder that Republicans and Democrats want to make allies of small business proprietors as they consider changing tax policy.

So when President Obama calls for repeal of President Bush's tax cuts for the very well-to-do, is he dealing a body blow to small business? It's a key question, especially at this vulnerable time for the economic recovery.

Small business is vital to the US economy. The Small Business Administration (SBA) notes that firms with fewer than 500 employees represent 99.7 percent of all US firms. They employ just over half of all private-sector workers and have generated 64 percent of net new jobs over the past 15 years.

A tax increase that hurts these engines of growth would slow an already glacial recovery.

Mr. Obama proposes to extend the Bush tax cuts for most Americans: couples making below $250,000 a year and single taxpayers earning below $200,000. More than 97 percent of small-business owners make less than that, an SBA official notes, and would avoid a tax increase.

How many? The SBA says there are 29 million small businesses and 97 percent of them wouldn't see a higher tax. So that leaves 3 percent or about 850,000 to 900,000 business owners.

Of course, many of those 900,000 don't fall into the usual definition of small business. They include partners in law firms, hedge fund managers, high-powered consultants, etc., who have maintained high incomes through the recession, notes Adam Looney, senior fellow at the Brookings Institution in Washington. These aren't "mom and pop" businesses.

Do these 900,000 have a disproportionate effect on hiring?

Probably not, says Roberton Williams, an economist at the Tax Policy Center in Washington. Those in that elevated income level often have income from investments and other sources than their "small business." So raising their top income tax level from 35 percent to 39.6 percent would probably have little impact on hiring. The decision to hire a new worker depends far more on demand for the services or products of a small business, not taxes. He sees the hiring argument as a "little disingenuous."

When the 39.6 percent marginal income tax rate was in effect in the 1990s, hiring was much higher than after the Bush tax cuts, he notes.

The rich would still pay less than they did in the 1990s, he reckons. The Obama proposal, besides maintaining the tax cuts for lower-income citizens, includes other provisions such as allowing dividends to be taxed as long-term capital gains, which disproportionately favors the wealthy.

It's even possible that not raising taxes could hurt small business in the long term, argues economist Leonard Burman, now teaching at Syracuse University. Full extension of all the Bush tax cuts would contribute $3.7 trillion to the deficit over the next 10 years, perhaps raising interest rates, which would do far more damage to small business than a tax hike he says.

Because the rich have such a large chunk of national income, the White House proposal would bring in about $700 billion over 10 years, reducing the forecast deficit.